Understanding The Concept Of A Charge On Immovable Property

Creation of a charge:

A charge can therefore be created only over immovable property and can be created either by an act of parties such as a contract or a compromise decree^[1] or by law. Several fiscal legislations and other central and local laws create a charge by providing that unpaid dues would be a charge / first charge on the immovable property of the person in default and these would be examples of charge create by law. There is some case law to the effect that a charge created by a decree of a court would fall within the meaning of "by operation of law".^[2] However, some high courts have also taken a contrary view.

No particular form of words is necessary to create a charge and all that is necessary is that there must be a clear intention to make a property security for payment of money in praesenti ^[3]. However, it has been held that a mere undertaking not to dispose of or alienate property or an undertaking to create a charge does not amount to a charge on the property^[4] nor is does a mere agreement to create a mortgage constitute a charge over the property^[5].

In regard to whether Section 59 of the TPA applies to the creation of a charge, that is, whether a charge can be created only by way of a registered instrument and whether it requires attestation by witnesses, it has been held by a larger bench of the Supreme Court^[6] that the second part of Section 100 of the TPA comes into play only once a charge has been created and that since a charge can be created even by operation of law which would not involve a registered instrument or attestation, looking to the language of Section 100, it could not have been the intention of the legislature to apply the provisions of Section 59 of the TPA to the creation of a charge by either mode and therefore instrument in writing and attestation are not necessary in order to create a charge. The court also held that the second paragraph of Section 100 which contemplates that a subsequent transferee may not have notice of the charge also suggests that a charge can be made without any writing. The court however held that, by virtue of Section 17(1)(b) of the Registration Act, 1908, if a charge of a value of Rs. 100 or upwards is sought to be created by a non-testamentary instrument, such instrument requires registration. Strangely, a subsequent judgment of a two judges bench of the Supreme Court^[7], despite noticing this earlier larger bench judgment, appears to have held that Section 59 of the TPA applies to creation of a charge by act of parties.

Apart from the provisions of the TPA and the Registration Act, 1908, it is advisable to consult other laws applicable to legal entities while creating a charge so as not to fall foul of any requirements thereof.^[8]

Charge v. Mortgage:

Although Section 100 of the TPA speaks of a charge as the creation of a security not amounting to a mortgage, the distinction between a charge and a mortgage gets blurred on account of what that very provision says next which is – "and all the provisions hereinbefore contained which apply to a simple mortgage shall, so far as may be, apply to such charge".

A simple mortgage is defined in Section 58(b) of the TPA, it is a mortgage without delivery of possession of the immovable property where the mortgagee has the right to sell to the mortgaged property for payment of the mortgage-money if the mortgagor fails to pay. Several provisions of Chapter IV of the TPA which would be applicable to a simple mortgage are, so far as may be, therefore made applicable to a charge. The rights and duties of a charge-holder and those of the person on whose property a charge is created are therefore akin to the rights and duties of a simple mortgagee and mortgagor respectively. However, it is always required to be kept in mind that the words 'so far as may be' indicate that all provisions which apply to simple mortgage may not ipso facto be applicable to a charge.^[9]

Order 34, Rule 15 of the Code of Civil Procedure provides for the remedy of enforcing a charge, and it inter alia provides that all the provisions of Order 34 which apply to a simple mortgage shall, so far as may be, apply to a charge. Therefore, in a suit for enforcement of a charge under Section 100 of the Act read with Order 34 Rule 15 Code of Civil Procedure, a decree for sale of the property, as in a suit for a mortgage, would have to be passed.^[10]

Despite the seemingly blurred distinction, a charge does not amount to a mortgage. While a charge can be created by act of parties or by operation of law, a mortgage can only be created by act of parties. A charge is thus a wider term since every mortgage is also a charge but every charge is not a mortgage.^[11] The essential distinction between a mortgage (which is defined in Section 58 of the TPA as "the transfer of interest in specific immovable property for the purpose of securing the payment of money advanced or to be advanced by way of loan an existing or future debt, or the performance of an engagement which may give rise to a pecuniary liability") and a charge is that, while a mortgage creates an interest in the property in favour of the mortgagee, a charge does not do so, and a charge only results in appropriation of the property to the satisfaction of the debt or obligation in question, or, in other words, the creation of a right of payment out of the property. The declaration that 'all the provisions hereinbefore contained which apply to a simple mortgage shall, so far as may be, apply to such charge' does not have the effect of changing the nature of a charge to one of interest in property.^[12]

It is also important to note that undoubtedly the creation a mortgage results in an interest in the property being carved out in favour of the mortgagee. However, this does not mean that the property ceases to be the property of the mortgagor. The title to the property remains with the mortgagor. Therefore, when a statutory first charge is created on the property of the person, the property subjected to the first charge is the entire property of the person. The interest of the mortgagee is not excluded from the first charge. The first charge would therefore have a priority over a mortgage.^[13]

Charge follows the property:

As a general proposition, just like a simple mortgage, a charge follows the property and can therefore be enforced even if the property has passed into the hands of others. However, this is not an absolute proposition.

The relevant part of the second paragraph of Section 100 of the TPA provides that, "..save as otherwise expressly provided by any law for the time being in force, no charge shall be enforced against any property in the hands of a person to whom such property has been transferred for consideration and without notice of the charge."

The first issue here is whether this provision applies only to an outright sale of a property which is subject to a charge or also to a gift and to other transfers of interest such as a mortgage. It has been held by a larger bench of the Supreme Court^[14] that the words "transferred for consideration" would necessarily mean that the provision would not apply to a gift of a property charged and therefore a donee of a property which is subject to a charge cannot derive any benefit or protection from the second paragraph of Section 100 of the TPA even though he may not have notice of the charge. In the same judgment, the Supreme Court, after drawing upon the definition of 'transfer of property' as contained in Section 5 of the TPA and also drawing upon the various provisions of the TPA which use different terminologies such as 'transfer of property', 'transfer of an interest in property', 'creation of an interest in or over property', 'transfer of a right to enjoy property', 'transfer of ownership' etc, to connote different concepts of transfer such as sale, gift, exchange, mortgage, lease, etc. and looking to the language used in the second paragraph of Section 100 of the TPA, came to the conclusion that the said provision refers only to an outright sale of property and not to a mortgage or any other transfer of a mere interest in a property. Therefore, even a mortgagee cannot derive any benefit from the second paragraph of Section 100 of the TPA.

A charge will therefore follow the property in the hands of a donee or mortgagee or any person having a limited interest in the property charged.

The next issue in connection with the second paragraph of Section 100 of the TPA is the implication of the words "without notice of the charge". In broad terms, if a property subject to a charge is sold and the transferee has no notice of the charge, the charge cannot be enforced in his hands. But it is necessary to understand the meaning of having notice.

Section 3 of the TPA provides that a person is said to have notice of a fact when he actually knows that fact, or when, but for willful abstention from an enquiry or search which he ought to have made, or gross negligence, he would have known it. From this provision and the Explanations contained therein, it is plain that the word 'notice' is of wider import than the word 'knowledge'. A person may not have actual knowledge of a fact but he may have notice or deemed notice or constructive notice of it.^[15]

In view of Explanation I of the said Section 3, wherever a charge is created by way of a registered instrument, the transferee is deemed to have notice of the charge as from the date of registration and cannot derive any benefit of the second paragraph of Section 100 of the TPA. If, however, a charge is not created by way of a registered instrument, such as when it is created by law, the issue would arise whether a person can be said to have notice of the charge and the words "but for willful abstention from an enquiry or search which he ought to have made, or gross negligence" used in Section 3 of the TPA would assume significance since they create a deeming fiction imputing notice. This would be a question of fact which would have to be decided on the evidence and circumstances of each case.

In a leading case on this issue arising in the Supreme Court^[16], the question was whether a purchaser of a property at a court auction could be said to have constructive notice of a statutory charge thereon in respect of municipal tax dues. The court, relying upon its earlier larger bench decision^[17], rejected the contention that the second paragraph of Section 100 of the TPA would not apply to auction sales and that auction purchasers purchased the property subject to all charges and encumbrances. On the issue of constructive notice, the court held: "Wilful abstention suggests conscious or deliberate abstention and gross negligence is indicative of a higher degree of neglect. Negligence is ordinarily understood as an omission to take such reasonable care as under the circumstances is the duty of a person of ordinary prudence to take. In other words it is an omission to do something which a reasonable man guided by considerations which normally regulate the conduct of human affairs would do or doing something which normally a prudent and reasonable man would not do. The question of wilful abstention or gross negligence and, therefore, of constructive notice considered from this point of view is generally a question of fact or at best mixed question of fact and law depending primarily on the facts and circumstances of each case and except for cases directly falling within the three explanations, no inflexible rule can be laid down to serve as a straight-jacket covering all possible contingencies. The question one has to answer in circumstances like the present is not whether the purchaser had the means of obtaining and might with prudent caution have obtained knowledge of the charge but whether in not doing so he acted with wilful abstention or gross negligence. Being a question depending on the behaviour of a reasonably prudent man, the Courts have to consider it in the background of Indian conditions. Courts in India should, therefore, be careful and cautious in seeking assistance from English precedents which should not be blindly or too readily followed." In the facts and circumstances of that case, the court held that the purchaser could not be reasonably fixed with any constructive notice.

It may however be noted that, despite Section 100 of the TPA, a purchaser of a property without notice may still be bound by the principle of lis pendens in cases where any suit in respect of the property is pending, and his right over such property may be affected by the outcome of such suit.

There is one vital aspect of the second paragraph of Section 100 of the TPA which is required to be noted, which is that it uses the words 'save as otherwise provided'. These words would imply that a charge can be enforced even against a purchaser without notice where a law expressly so provides.^[18]

Charge v. Attachment and Injunction:

Lastly, certain concepts such as 'attachment' and 'injunction' need to be distinguished from the concept of 'charge'. As observed by the Supreme Court^[19], an attachment would only mean 'taking into the custody of the law the person or property of one already before the court, or of one whom it is sought to bring before it'. It is used for two purposes: (i) to compel the appearance of a defendant; and (ii) to seize and hold his property for the payment of the debt. It may also mean prohibition of transfer, conversion, disposition or movement of property by an order issued by the court. The sole object behind an attachment before judgment is to give an assurance to the plaintiff that his decree if made would be satisfied and that behind an attachment for execution is to see that the process of court is not defeated once execution starts. It is a sort of a guarantee against decree becoming infructuous for want of property available from which the plaintiff can satisfy the decree. An attachment does not create a charge on the property.

Similarly, a temporary or perpetual injunction also does not create a charge over the property. A temporary injunction is primarily concerned with the preservation of the property in dispute till legal rights are adjudicated. Injunction is a judicial process by which a party is required to do or to refrain from doing any particular act. It is in the nature of preventive relief to a litigant to prevent future possible injury.^[20] A perpetual injunction is where the defendant is perpetually enjoined from the assertion of a right, or from the commission of an act, which would be contrary to the rights of the plaintiff.^[21]

Thus, merely by virtue of an order of attachment or injunction in respect of a property, the person in whose favour such order exists, would not have the status and rights of a charge-holder.

Conclusion:

The subject of charge and mortgage is vast and many complexities and complications, such as conflicting provisions of law or conflicting interests or claims in or over a property, do arise often in the course of commercial transactions, and such issues would have to be determined based on peculiar facts and circumstances along with applicable law.